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CORPORATE FINANCIAL REPORTING 2

17 – Investments. CORPORATE FINANCIAL REPORTING 2. Debt investments Equity investments Preferred stock Common stock. I NVESTMENTS I N O THER C OMPANIES. PASSIVE ACCOUNTING METHOD TO USE: INVESTMENT ACTIVE INVESTMENT Fair value Equity method

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CORPORATE FINANCIAL REPORTING 2

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  1. 17 – Investments CORPORATEFINANCIAL REPORTING 2 Investments

  2. Debt investments Equity investments Preferred stock Common stock INVESTMENTS IN OTHER COMPANIES Investments

  3. PASSIVEACCOUNTING METHOD TO USE: INVESTMENTACTIVE INVESTMENT Fair valueEquity method significant control (in US) influence Consolidate 1 share (20%) 50% 100% of stock | | | | EQUITY INVESTMENTSCommon stock Investments

  4. PASSIVE INVESTMENT Fair value 1 share (20%) | | Trading security orSecurity available for sale The difference is where the “unrealized” (holding) gains/losses will appear. REPORTING “PASSIVE” INVESTMENTS Investments

  5. International rules differ slightly, but in general: Trading Securities are meant to be held for short periods of time and are part of a company’s “operating activity.” Securities Available for Sale are not part of a company’s “operating activity” rather they are investments made as a short or long term investment to generate financing (not operating) profits. Held to maturity securities– investments in bonds payable. REPORTING “PASSIVE” INVESTMENTS Investments

  6. A brief aside - a visit to the “hidden” income statement - Other Comprehensive Income and a kind of 2nd Retained Earnings account – Additional Comprehensive Income. (see ASU 220) REPORTING “PASSIVE” INVESTMENTS Investments

  7. In Feb. 2013, our company buys shares of X Company common stock for $10,000 (includes broker charges). On Mar. 31, 2013, our X stock has a fair value of $9,000. On June 30, 2013, our X stock has a fair value of $12,000. In July, 2013, our company buys shares of Y company for $14,000. On Sep. 30, 2013, our X stock is worth $12,200; Y is worth $13,300. In Oct. 2013, we sell our X stock for $12,700, On Dec. 31, 2013, our Y stock is worth $13,000 Scenario A: IF TRADING SECURITY (unrealized gains and losses on the income statement). The tax rate is 40%. REPORTING “PASSIVE” INVESTMENTS (our company prepares quarterly f/s) Investments

  8. In Feb. 2013, our company buys shares of X Company common stock for $10,000 (includes broker charges). On Mar. 31, 2013, our X stock has a fair value of $9,000. On June 30, 2013, our X stock has a fair value of $12,000. In July, 2013, our company buys shares of Y company for $14,000. On Sep. 30, 2013, our X stock is worth $12,200; Y is worth $13,300. In Oct. 2013, we sell our X stock for $12,700, On Dec. 31, 2013, our Y stock is worth $13,000 Scenario B: IF SEC. AVAIL. FOR SALE (unrealized gains and losses in Other Comprehensive Income). The tax rate is 40%. REPORTING “PASSIVE” INVESTMENTS (our company prepares quarterly f/s) Investments

  9. ACTIVE INVESTMENT Equity method significant influence (20%?) 50% 100% of stock | | | EQUITY INVESTMENTS for voting stock (usually just common) Investments

  10. On Jan. 2, 2013, Co. A acquires 25% of Co. B’s stock from B’s stockholders for $28,000 cash. Assume the following is A’s balance sheet Assume the following values for B’s assets/liabilities before acquiring B’s stock: BookValueMarket Value cash $ 200,000 cash $ 1,000 $ 1,000 acct. rec. 300,000 acct. rec. 8,000 8,000 inventory 500,000 inventory 12,000 15,000 PPE 900,000 PPE 110,000 90,000 accum. deprec (300,000) accum. deprec (30,000) patent 2,000 patent 1,000 0 trademark 3,000trademark - 2,000 $1,605,000$102,000$116,000 liabilities 100,000 liabilities 10,000 $ 10,000 com. stock 300,000 com. stock 30,000 APIC 350,000 APIC 35,000 ret. earnings 855,000ret. earnings 27,000 $1,605,000$102,000 THE EQUITY METHOD Investments

  11. What journal entry would Co. A’s accountant make? Then Co. A’s accountant would ask “Why did we pay so much?” THE EQUITY METHOD Investments

  12. A’s balance sheet after acquiring B’s stock: cash $ 172,000 acct. rec. 300,000 inventory 500,000 25% of B’s OE 23,000 PPE 900,000 trademark 500 accum. deprec (300,000) patent ( 250) Invest. in Co. B 28,000 PPE 2,500 patent 1,000 inventory 750 trademark 3,000 goodwill 1,500 trade secret -28,000 $1,604,000 liabilities 100,000 com. stock 300,000 APIC 350,000 ret. earnings 854,000 $1,604,000 THE EQUITY METHOD Investments

  13. On 12/31/2013, Co. B reports $20,500 of net income and pays $10,000 in dividends. What journal entries will Co. A make? To answer this we need think about the Investment in Co. B account the way an accountant does. THE EQUITY METHOD Investments

  14. Company A wants to expand – two common ways of doing that are: (1) buying Company B’s assets and assuming its liabilities and (2) buying enough stock in Company B to control Company B. TWO COMMON WAYS TO OBTAIN CONTROL Investments

  15. ACCOUNTING METHOD TO USE: ACTIVE INVESTMENT Equity method control (in US) Consolidate 50% 100% of stock | | EQUITY INVESTMENTSfor voting stock (usually just common) Investments

  16. Co. A pays $135,000 to Co. B’s owners to buy 90% of Co. B’s stock; the fair value of the remaining 10% of Co. B’s stock is $12,000.Assume the following is A’s balance sheet Assume the following values for B’s assets/liabilities before acquiring B’s stock: BookValueMarket Value cash $ 200,000 cash $ 1,000 $ 1,000 acct. rec. 300,000 acct. rec. 8,000 8,000 inventory 500,000 inventory 12,000 15,000 PPE 900,000 PPE 110,000 90,000 accum. deprec (300,000) accum. deprec (30,000) patent 2,000 patent 1,000 0 trademark 3,000trademark - 2,000 $1,605,000$102,000$116,000 liabilities 100,000 liabilities 10,000 $ 10,000 com. stock 300,000 com. stock 30,000 APIC 350,000 APIC 35,000 ret. earnings 855,000ret. earnings 27,000 $1,605,000$102,000 BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  17. This is what happened: Owners of A Owners of B $135,000 90% Co. Co. A BstockCo. B What will Co. A’s journal entry look like? BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  18. This is “after”: Owners of A Owners of B 10% owners Co. A 90% owner Co. B BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  19. A’s balance sheet after the transaction: cash $ 65,000 liabilities 100,000 acct. rec. 300,000 inventory 500,000 com. stock 300,000 Invest. in B stock 135,000 APIC 350,000 PPE 900,000 ret. earnings 855,000 accum. deprec (300,000) $1,605,000 patent 2,000 trademark 3,000 $1,605,000 BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  20. B’s balance sheet after the transaction: cash $ 1,000 acct. rec. 8,000 inventory 12,000 PPE 110,000 accum. deprec (30,000) patent 1,000 trademark - $102,000 liabilities 10,000 com. stock 30,000 APIC 35,000 ret. earnings 27,000 $102,000 BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  21. Then A’s accountant asks: “Why did A pay so much?” The answer lies in a previous slide and our previous thought process,but with a modification. BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  22. FASB (and International Accounting Standards) says that if one company controls another company the controlling company needs to do something more than use the equity method. BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  23. What FASB also wants: Owners of A F/S Co. A consolidated F/S F/S Co. B BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  24. What appears in the consolidated balance sheet are the assets and liabilities that Co. A controls, directly and indirectly (which would include Co. B’s assets and liabilities). BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  25. And the key is - the Investment in B Stock account on Co. A’s balance sheet really represents control of Co. B’s assets and liabilities BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  26. A’s balance sheet after the transaction: cash $ 65,000 liabilities 100,000 acct. rec. 300,000 com. stock 300,000 inventory 500,000 APIC 350,000 Invest. in B stock 135,000 ret. earnings 855,000 PPE 900,000 $1,605,000 accum. deprec (300,000) cash 1,000 patent 2,000 acct. rec. 8,000 trademark 3,000inventory 15,000 PPE 90,000 $1,605,000patent 0 trademark 2,000 goodwill 41,000 liabilities (10,000) BUYING CO. B’s STOCK – A Consolidation Example

  27. So, Co. A’s consolidated balance sheet “substitutes” the assets and liabilities Co. A controls when it bought Co. B’s stock. BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  28. A’s consolidated Balance Sheet: cash $ 66,000 liabilities 110,000 acct. rec. 308,000 inventory 515,000 N.C.I. * 12,000 Invest. in B stock - com. stock 300,000 PPE 990,000 APIC 350,000 accum. deprec. (300,000) ret. earnings 855,000 patent 2,000 $1,627,000 trademark 5,000 WHEW! goodwill 41,000 $1,627,000 * NONCONTROLLING INTEREST IN NET ASSETS OF SUBSIDIARY BUYING CO. B’s STOCK – A Consolidated Balance Sheet Consolidated Financial Statements

  29. One year later, these were the income statements for A and B: A B Sales revenue $200,000 $70,000COGS ( 80,000) ( 36,000)Deprec. exp. ( 45,000) ( 5,500)Pat. amort. exp. ( 400) ( 200)Other exp. ( 14,600)( 7,800)Net income $ 60,000$20,500 and B paid $10,000 in cash dividends. What entries would A’s accountant make (assuming A uses the equity method)? BUYING CO. B’s STOCK – A Consolidated Income Statement Consolidated Financial Statements

  30. A’s income statement that it would issue to thepublic (IF it issued a non-consolidated income statement): Sales revenue $200,000 COGS ( 80,000) Deprec. exp. ( 45,000) Pat. amort. exp. ( 400)Other expenses ( 14,600)Equity income 15,030Net income $ 75,030 BUYING CO. B’s STOCK – A Consolidated Income Statement Consolidated Financial Statements

  31. What would appear in A’sconsolidated Income Statement: Sales revenue $270,000 COGS (119,000) Deprec. exp. ( 51,500) Pat. amort. exp. ( 400) Other exp. ( 22,400)Equity income --Consol. net income $ 76,700 Net income to N.C.I ( 1,670) Net income to Co. A $ 75,030 BUYING CO. B’s STOCK – A Consolidated Income Statement Consolidated Financial Statements

  32. Co. A’s accountant also must prepare a consolidated owners’ equity statement and a consol-idated cash flow statement. BUYING CO. B’s STOCK Consolidated Financial Statements

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